Solution manual intermediate accounting 13e kieso ch17

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 17 Investments ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Questions Debt securities Brief Exercises Exercises 1, 2, 3, 13 Problems 2, 3, Concepts for Analysis 4, (a) Held-to-maturity 4, 5, 7, 8, 10, 13, 21 1, 1, (b) Trading 4, 6, 7, 8, 10, 21 (c) Available-for-sale 4, 7, 8, 9, 10, 11, 21 2, 10 1, 2, 3, 4, Bond amortization 8, 1, 2, 3, 4, 1, 2, 3 Equity securities 1, 12, 16 1, 1, 4, (a) Available-for-sale 7, 10, 11, 15, 21 5, 6, 8, 9, 11, 12, 16, 19, 20 5, 6, 8, 9, 10, 11, 12 1, 2, (b) Trading 6, 7, 8, 10, 14, 15, 21 6, 7, 14, 15 6, 1, (c) Equity method 16, 17, 18, 19, 20 12, 13, 16, 17 5, Comprehensive income 22 10 10, 12 Disclosures of investments 21 8, 5, 8, 9, 10, 11, 12 Fair value option 25, 26, 27 19, 20, 21 Impairments 24 Transfers between categories 23 *9 Derivatives *10 Variable Interest Entities 10 31, 32, 33, 34, 35, 36, 37, 38 18 1, 3, 22, 23, 24, 25, 26, 27 13, 14, 15, 16, 17, 18 39, 40 *This material is dealt with in an Appendix to the chapter Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) 17-1 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Brief Exercises Learning Objectives Exercises Problems Identify the three categories of debt securities and describe the accounting and reporting treatment for each category Understand the procedures for discount and premium amortization on bond investments 1, 2, 3, 2, 3, 4, 5, 21 1, 2, 3, 4, Identify the categories of equity securities and describe the accounting and reporting treatment for each category 5, 6, 1, 6, 7, 8, 9, 11, 12, 14, 15, 16, 19, 20, 21 3, 5, 6, 8, 9, 10, 11, 12 Explain the equity method of accounting and compare it to the fair value method for equity securities 12, 13, 16, 17 Describe the accounting for the fair value option 19, 20, 21 8, 9, 10, 12 Discuss the accounting for impairments of debt and equity investments 10 18 Explain why companies report reclassification adjustments 10 Describe the accounting for transfer of investment securities between categories *9 Explain who uses derivatives and why *10 Understand the basic guidelines for accounting for derivatives *11 Describe the accounting for derivative financial instruments 22, 26 13, 14, 15 *12 Explain how to account for a fair value hedge 23, 25 16, 18 *13 Explain how to account for a cash flow hedge 24, 27 17 17-2 Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ASSIGNMENT CHARACTERISTICS TABLE Item E17-1 E17-2 E17-3 E17-4 E17-5 E17-6 E17-7 E17-8 E17-9 E17-10 E17-11 E17-12 E17-13 E17-14 E17-15 E17-16 E17-17 E17-18 E17-19 E17-20 E17-21 *E17-22 *E17-23 *E17-24 *E17-25 *E17-26 *E17-27 P17-1 P17-2 P17-3 P17-4 P17-5 P17-6 P17-7 P17-8 P17-9 Description Investment classifications Entries for held-to-maturity securities Entries for held-to-maturity securities Entries for available-for-sale securities Effective-interest versus straight-line bond amortization Entries for available-for-sale and trading securities Trading securities entries Available-for-sale securities entries and reporting Available-for-sale securities entries and financial statement presentation Comprehensive income disclosure Equity securities entries Journal entries for fair value and equity methods Equity method Equity investment—trading Equity investments—trading Fair value and equity method compared Equity method Impairment of debt securities Fair Value measurement Fair Value measurement Fair value option Derivative transaction Fair value hedge Put and call cash flow hedge options Fair value hedge Call option Cash flow hedge Debt securities Available-for-sale debt securities Available-for-sale investments Available-for-sale debt securities Equity securities entries and disclosures Trading and available-for-sale securities entries Available-for-sale and held-to-maturity debt securities entries Fair value and equity methods Financial statement presentation of available-for-sale investments Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual Level of Difficulty Time (minutes) Simple Simple Simple Simple Simple Simple Simple Simple Simple 5–10 10–15 15–20 10–15 20–30 10–15 10–15 5–10 10–15 Moderate Simple Simple Moderate Moderate Moderate Simple Simple Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate 20–25 20–25 15–20 10–15 10–15 15–20 15–20 10–15 15–20 15–20 15–20 15–20 15–20 20–25 20–25 15–20 20–25 25–30 Moderate Moderate Moderate Moderate Moderate Simple Moderate Moderate Moderate 30–40 30–40 25–30 25–35 25–35 25–35 25–35 20–30 20–30 (For Instructor Use Only) 17-3 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ASSIGNMENT CHARACTERISTICS TABLE (Continued) Item P17-10 P17-11 P17-12 *P17-13 *P17-14 *P17-15 *P17-16 *P17-17 *P17-18 CA17-1 CA17-2 CA17-3 CA17-4 CA17-5 CA17-6 CA17-7 17-4 Description Gain on sale of securities and comprehensive income Equity investments—available-for-sale Available-for-sale securities—statement presentation Derivative financial instrument Derivative financial instrument Free-standing derivative Fair value hedge interest rate swap Cash flow hedge Fair value hedge Level of Difficulty Moderate Complex Moderate Moderate Moderate Moderate Moderate Moderate Moderate Time (minutes) 20–30 35–45 20–30 20–25 20–25 20–25 30–40 25–35 25–35 Issues raised about investment securities Equity securities Financial statement effect of equity securities Equity securities Investment accounted for under the equity method Equity investment Fair value—ethics Moderate Moderate Simple Moderate Simple Moderate Moderate 25–30 25–30 20–30 20–25 15–25 25–35 25–35 Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com SOLUTIONS TO CODIFICATION EXERCISES CE17-1 Master Glossary (a) Trading securities are securities that are bought and held principally for the purpose of selling them in the near term and therefore held for only a short period of time Trading generally reflects active and frequent buying and selling, and trading securities are generally used with the objective of generating profits on short-term differences in price (b) A holding gain or loss is the net change in fair value of a security The holding gain or loss does not include dividend or interest income recognized but not yet received or write-downs for otherthan-temporary impairment (c) A cash flow hedge is a hedge of the exposure to variability in the cash flows of a recognized asset or liability, or of a forecasted transaction, that is attributable to a particular risk (d) A fair value hedge is a hedge of the exposure to changes in the fair value of a recognized asset or liability, or of an unrecognized firm commitment, that are attributable to a particular risk CE17-2 According to FASB ASC 235-10-S99-1 (Notes to Financial Statements—SEC Materials): Disclosures regarding accounting policies shall include descriptions of the accounting policies used for derivative financial instruments and derivative commodity instruments and the methods of applying those policies that materially affect the determination of financial position, cash flows, or results of operation This description shall include, to the extent material, each of the following items: (a) A discussion of each method used to account for derivative financial instruments and derivative commodity instruments; (b) The types of derivative financial instruments and derivative commodity instruments accounted for under each method; (c) The criteria required to be met for each accounting method used, including a discussion of the criteria required to be met for hedge or deferral accounting and accrual or settlement accounting (e g., whether and how risk reduction, correlation, designation, and effectiveness tests are applied); (d) The accounting method used if the criteria specified in paragraph (n)(3) of this section are not met; (e) The method used to account for terminations of derivatives designated as hedges or derivatives used to affect directly or indirectly the terms, fair values, or cash flows of a designated item; (f) The method used to account for derivatives when the designated item matures, is sold, is extinguished, or is terminated In addition, the method used to account for derivatives designated to an anticipated transaction, when the anticipated transaction is no longer likely to occur; and (g) Where and when derivative financial instruments and derivative commodity instruments, and their related gains and losses, are reported in the statements of financial position, cash flows, and results of operations Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) 17-5 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CE17-3 According to FASB ASC 323-10-35-20 (Investments—Equity Method and Joint Ventures—Subsequent Measurement): The investor ordinarily shall discontinue applying the equity method if the investment (and net advances) is reduced to zero and shall not provide for additional losses unless the investor has guaranteed obligations of the investee or is otherwise committed to provide further financial support for the investee CE17-4 According to FASB ASC 815-10-45-4 (Derivatives and Hedging—Other Presentation Matters—Balance Sheet Netting); Unless the conditions in paragraph 210-20-45-1 are met, the fair value of derivative instruments in a loss position shall not be offset against the fair value of derivative instruments in a gain position Similarly, amounts recognized as accrued receivables shall not be offset against amounts recognized as accrued payables unless a right of setoff exists 17-6 Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANSWERS TO QUESTIONS A debt security is an instrument representing a creditor relationship with an enterprise Debt securities include U.S government securities, municipal securities, corporate bonds, convertible debt, and commercial paper Trade accounts receivable and loans receivable are not debt securities because they not meet the definition of a security An equity security is described as a security representing an ownership interest such as common, preferred, or other capital stock It also includes rights to acquire or dispose of an ownership interest at an agreed-upon or determinable price such as warrants, rights, and call options or put options Convertible debt securities and redeemable preferred stocks are not treated as equity securities The variety in bond features along with the variability in interest rates permits investors to shop for exactly the investment that satisfies their risk, yield, and marketability desires, and permits issuers to create a debt instrument best suited to their needs Cost includes the total consideration to acquire the investment, including brokerage fees and other costs incidental to the purchase The three types of classifications are: Held-to-maturity: Debt securities that the enterprise has the positive intent and ability to hold to maturity Trading: Debt securities bought and held primarily for sale in the near term to generate income on short-term price differences Available-for-sale: Debt securities not classified as held-to-maturity or trading securities A debt security should be classified as held-to-maturity only if the company has both: (1) the positive intent and (2) the ability to hold those securities to maturity Trading securities are reported at fair value, with unrealized holding gains and losses reported as part of net income and any discount or premium is amortized Trading and available-for-sale securities should be reported at fair value, whereas held-tomaturity securities should be reported at amortized cost $3,500,000 X 10% = $350,000; $350,000 ÷ = $175,000 Wheeler would make the following entry: Cash ($4,000,000 X 8% X 1/2) Bond Investment Interest Revenue ($3,500,000 X 10% X 1/2) 160,000 15,000 Securities Fair Value Adjustment (Available-for-Sale) Unrealized Holding Gain or Loss—Equity [$3,604,000 – ($3,500,000 + $15,000)*] 89,000 175,000 89,000 *See number 10 Unrealized holding gains and losses for trading securities should be included in net income for the current period Unrealized holding gains and losses for available-for-sale securities should be reported as other comprehensive income and as a separate component of stockholders’ equity Unrealized holding gains and losses are not recognized for held-to-maturity securities Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) 17-7 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 17 (Continued) 11 (a) Unrealized Holding Gain or Loss—Equity Securities Fair Value Adjustment (Available-for-Sale) (b) 60,000 60,000 Unrealized Holding Gain or Loss—Equity Securities Fair Value Adjustment (Available-for-Sale) 70,000 70,000 12 Investments in equity securities can be classified as follows: (a) Holdings of less than 20% (fair value method)—investor has passive interest (b) Holdings between 20% and 50% (equity method)—investor has significant influence (c) Holdings of more than 50% (consolidated statements)—investor has controlling interest Holdings of less than 20% are then classified into trading and available-for-sale, assuming determinable fair values 13 Investments in stock not have a maturity date and therefore cannot be classified as held-tomaturity securities 14 Gross selling price of 10,000 shares at $27.50 Less: Brokerage commissions Proceeds from sale Cost of 10,000 shares Gain on sale of stock Cash Trading Securities Gain on Sale of Stock $275,000 (1,770) 273,230 (260,000) $ 13,230 273,230 260,000 13,230 15 Both trading and available-for-sale equity securities are reported at fair value However, any unrealized holding gain or loss is reported in net income for trading securities but as other comprehensive income and as a separate component of stockholders’ equity for available-forsale securities 16 Significant influence over an investee may result from representation on the board of directors, participation in policy-making processes, material intercompany transactions, interchange of managerial personnel, or technological dependency An investment (direct or indirect) of 20% or more of the voting stock of an investee constitutes significant influence unless there exists evidence to the contrary 17 Under the equity method, the investment is originally recorded at cost, but is adjusted for changes in the investee’s net assets The investment account is increased (decreased) by the investor’s proportionate share of the earnings (losses) of the investee and decreased by all dividends received by the investor from the investee 18 The following disclosures in the investor’s financial statements are generally applicable to the equity method: (a) (b) (c) (d) 17-8 The name of each investee and the percentage of ownership of common stock The accounting policies of the investor with respect to investments in common stock The difference, if any, between the amount in the investment account and the amount of underlying equity in the net assets of the investee The aggregate value of each identified investment based on quoted market price (if available) Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 17 (Continued) (e) When investments of 20% or more interest are, in the aggregate, material in relation to the financial position and operating results of an investor, it may be necessary to present summarized information concerning assets, liabilities, and results of operations of the investees, either individually or in groups, as appropriate 19 Dividends subsequent to acquisition should be accounted for as a reduction in the investment in common stock account 20 Ordinarily, Raleigh Corp should discontinue applying the equity method and not provide for additional losses beyond the carrying value of $170,000 However, if Raleigh Corp.’s loss is not limited to its investment (due to a guarantee of Borg’s obligations or other commitment to provide further financial support or if imminent return to profitable operations by Borg appears to be assured), it is appropriate for Raleigh Corp to provide for its entire $186,000 share of the $620,000 loss 21 Trading securities should be reported at aggregate fair value as current assets Individual held-tomaturity and available-for-sale securities are classified as current or noncurrent depending upon the circumstances Held-to-maturity securities generally should be classified as current or noncurrent, based on the maturity date of the individual securities Debt securities identified as available-for-sale should be classified as current or noncurrent, based on maturities and expectations as to sales and redemptions in the following year Equity securities identified as available-for-sale should be classified as current if these securities are available for use in current operations 22 Reclassification adjustments are necessary to insure that double counting does not result when realized gains or losses are reported as part of net income but also are shown as part of other comprehensive income in the current period or in previous periods 23 When a security is transferred from one category to another, the transfer should be recorded at fair value, which in this case becomes the new basis for the security Any unrealized gain or loss at the date of the transfer increases or decreases stockholders’ equity The unrealized gain or loss at the date of the transfer to the trading category is recognized in income 24 A debt security is impaired when “it is probable that the investor will be unable to collect all amounts due according to the contractual terms.” When an impairment has occurred, the security is written down to its fair value, which is also the security’s new cost basis The amount of the writedown is accounted for as a realized loss 25 Fair Value is now defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Fair value is therefore a market-based measure 26 The fair value option gives companies the option to report most financial instruments at fair value with all gains and losses related to changes in fair value reported in the income statement This option is applied on an instrument by instrument basis The fair value option is generally available only at the time a company first purchases the financial asset or incurs a financial liability If a company chooses to use the fair value option, it must measure this instrument at fair value until the company no longer has ownership 27 No The fair value option is generally available only at the time a company first purchases the financial asset or incurs a financial liability If a company chooses to use the fair value option, it must measure this instrument at fair value until the company no longer has ownership 28 The accounting for investment securities is discussed in IAS 27 (“Consolidated and Separate Financial Statements”), IAS 28 (“Accounting for Investments in Associates”), and IAS 39 (“Financial Instruments: Recognition and Measurement”) Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) 17-9 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 17 (Continued) 29 The accounting and reporting under iGAAP and U.S GAAP are for the most part very similar, although the criteria used to determine the accounting is often different For example, among the notable similarities are: (1) the accounting for trading, available-for-sale, and held-to-maturity securities is essentially the same between iGAAP and U.S GAAP; (2) both iGAAP and U.S GAAP use the same test to determine whether the equity method of accounting should be used—that is, significant influence with a general guide of over 20% ownership iGAAP uses the term associate investment rather than equity investment to describe its investment under the equity method; (3) reclassifications of securities from one category to another generally follow the same accounting under the two GAAP systems Reclassification in and out of trading securities is prohibited under iGAAP It is not prohibited under U.S GAAP, but this type of reclassification should be rare Differences include: (1) Gains and losses related to available-for-sale securities are reported in other comprehensive income under U.S GAAP Under iGAAP, these gains and losses are reported directly in equity; (2) under iGAAP, both the investor and an associate company should follow the same accounting policies As a result, in order to prepare financial information, adjustments are made to the associate’s policies to conform to the investor’s books; (3) the basis for consolidation under iGAAP is control Under U.S GAAP, a bipolar approach is used, which is a risk-and-reward model (often referred to as a variable-entity approach) and a voting-interest approach However, under both systems, for consolidation to occur, the investor company must generally own 50% of another company; (4) U.S GAAP does not permit the reversal of an impairment charge related to available-for-sale debt and equity investments iGAAP follows the same approach for available-for-sale equity investments but permits reversal for available-forsale debt securities and held-to-maturity securities 30 Under U.S GAAP, Ramirez makes no entry, because impaired investments may not be written up if they recover in value Under iGAAP, Ramirez makes the following entry: Available-for-Sale Impairment Recovery of Loss on Investment 300,000 300,000 *31 An underlying is a special interest rate, security price, commodity price, index of prices or rates, or other market-related variable Changes in the underlying determine changes in the value of the derivative Payment is determined by the interaction of the underlying with the face amount and the number of shares, or other units specified in the derivative contract (these elements are referred to as notional amounts) *32 See illustration below: Traditional Financial Instrument (e.g., Trading Security) Derivative Financial Instrument (e.g., Call Option) Payment Provision Stock price times the number of shares Initial Investment Settlement Investor pays full cost Deliver stock to receive cash Change in stock price (underlying) times number of shares (notional amount) Initial investment is less than full cost Receive cash equivalent, based on changes in stock price times the number of shares Feature For a traditional financial instrument, an investor generally must pay the full cost, while derivatives require little initial investment In addition, the holder of a traditional security is exposed to all risks of ownership, while most derivatives are not exposed to all risks associated with ownership in the underlying For example, the intrinsic value of a call option only can increase in value Finally, unlike a traditional financial instrument, the holder of a derivative could realize a profit without ever having to take possession of the underlying This feature is referred to as net settlement and serves to reduce the transaction costs associated with derivatives 17-10 Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com SOLUTIONS TO CONCEPTS FOR ANALYSIS CA 17-1 Situation GAAP requires that securities which are classified as trading securities be reported on the balance sheet at their fair value amount Any changes in the fair value of trading securities from one period to another are included in earnings Therefore, the $4,200 decrease will be reported on the income statement as an unrealized holding loss Situation The security should be reported in the available-for-sale category at the current fair value The transfer of the security affects earnings because the unrealized loss at the date of transfer is recognized in the income statement Situation The reclassification does not affect earnings and the available-for-sale security will continue to be reported at its fair value Situation When a reduction in the fair value of a security is considered to be an impairment, the new cost basis of the security is its fair value The security is written down to the fair value amount and the loss is included in earnings In this case, the fair value of the security at the end of the prior year is the new cost basis However, since the security is classified as available-for-sale, the fair value at the end of the current year is reported on the balance sheet Therefore, the increase in fair value will not affect earnings but instead is reported as other comprehensive income and as a separate component of stockholders’ equity Situation The securities would be classified as available-for-sale securities since management’s intention is neither to hold the securities for the entire term nor to sell the securities in the near future (less than months) Available-for-sale securities are reported on the balance sheet at the fair value The unrealized holding loss of $7,700 is excluded from earnings and instead is reported as other comprehensive income and as a separate component of stockholders’ equity CA 17-2 (a) 17-70 The reporting of available-for-sale securities at fair value provides the financial statement user with more relevant financial information The fair value of the securities is essentially the present value of the securities’ future cash flows and so this helps investors and creditors assess the entity’s liquidity Also, the fair value of the securities helps the financial statement user to assess the entity’s investment strategies The financial statements of the entity will reflect which investments have increased in fair value and which investments have decreased in fair value However, since these securities have not been purchased with the intention of selling them in the near future, the portfolio is not managed to the same degree as trading securities Therefore, if changes in the fair value of the available-for-sale securities were also included in earnings, the possibility exists that earnings could potentially be very unstable Thus, to reduce this concern, any changes in fair value of the available-for-sale securities are excluded from earnings and instead recorded as other comprehensive income and as a separate component of stockholders’ equity Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CA 17-2 (Continued) (b) Lexington Company should record the following journal entry and then report the following amounts on its balance sheet December 31, 2010 Unrealized Holding Gain or Loss—Equity Securities Fair Value Adjustment (Available-for-Sale) 1,100 1,100 Balance Sheet—December 31, 2010 Long-term investment: Available-for-sale securities, at cost Less: Securities fair value adjustment Available-for-sale securities, at fair value $49,500 1,100 $48,400 Stockholders’ equity: Common stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total stockholders’ equity $ XXX XXX XXX (1,100) $ XXX Securities classified as available-for-sale securities should initially be recorded at their acquisition price The valuation of these securities is subsequently reported at their fair value Any changes in the fair value of the securities are recorded in an unrealized holding gain or loss account, which is included as other comprehensive income and as a separate component of stockholders’ equity Assuming the company prepared a statement of comprehensive income, it would show an unrealized holding loss of $1,100 during the period (c) No, Lexington Company did not properly account for the sale of the Summerset Company stock The cost basis of the Summerset stock is still $9,500 Therefore, Lexington should have recorded a $300 ($9,200 – $9,500) loss from the sale of the securities as follows: Cash Loss on Sale of Securities Available-for-Sale Securities (d) 9,200 300 9,500 December 31, 2011 Securities Fair Value Adjustment (Available-for-Sale) Unrealized Holding Gain or Loss—Equity 1,500 1,500 Available-for-sale securities are reported at their fair value Therefore, an adjusting entry must be made to show the $400 excess of fair value over cost in the portfolio The unrealized holding loss from the previous period must be reversed As a result, $1,500 adjustment is needed to correctly state the available-for-sale portfolio Securities Greenspan Corp stock Tinkers Company stock Total of portfolio Previous fair value adjustment balance—Cr Securities fair value adjustment—Dr Copyright © 2010 John Wiley & Sons, Inc Cost $20,000 20,000 $40,000 Kieso, Intermediate Accounting, 13/e, Solutions Manual Fair Value $19,900 20,500 $40,400 Unrealized Gain (Loss) ($ (100) ( 500) $ 400 ( (1,100) ($1,500 (For Instructor Use Only) 17-71 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CA 17-3 Situation The carrying value of the trading security will be the fair value on the date of the transfer The unrealized holding loss, the difference between the current fair value and the cost, will be recognized immediately Situation When a decrease in the fair value of a security is considered to be other than temporary, an impairment in the value of the security has occurred As a result, the security is written down to the fair value and this becomes the new cost basis of the security The security is reported on the balance sheet at its current fair value The amount of the write-down is included in earnings as a realized loss Situation Both the portfolio of trading securities and the portfolio of available-for-sale securities are reported at their fair value The $13,500 decrease in fair value of the trading portfolio is recorded in the unrealized holding loss account and is included in earnings for the period The $28,600 increase in fair value of the available-for-sale portfolio is recorded in the unrealized holding gain account and is not included in earnings for the period Instead, the unrealized holding gain is shown as other comprehensive income and as a separate component of stockholders’ equity CA 17-4 (a) A company maintains the different investment portfolios because each portfolio serves a different investment objective Since each portfolio serves a different objective, the possible risks and returns associated with that objective should be disclosed in the financial statements This disclosure allows the financial statement user to assess the investment strategies for the company's investments, which when classified as trading securities are designed to return a profit to the entity on the basis of short-term price changes On the other hand, investments which are classified as held-to-maturity securities are designed to provide a steady stream of interest revenue Investments which are classified as available-for-sale securities include the investments which are not classified in either of the first two categories The combination of these three categories helps management to disclose in greater detail how it is investing its funds (b) The factors which should be considered when determining how to properly classify investment securities are: (1) management’s intent and (2) the ability to hold the securities to maturity Management’s intent is simply the purpose for which management has made the investment If management is planning to sell the security in the near future (less than three months) and to earn its profit on the basis of any price change, then the security should be classified as a trading security On the other hand, if management has the intent and ability to hold the security until its maturity, then the security should be classified as a held-to-maturity security This category is restrictive in the sense that management must have the positive intent to hold the security to maturity If management’s intentions not match either of the above categories, then the security should be classified as an available-for-sale security If a company does not intend to hold trading or available-for-sale securities until maturity, the securities are reported on the balance sheet at fair value Therefore, if the price of the securities decreases while the company is holding the securities, the company may incur an unrealized holding loss The treatment of the unrealized loss is determined by the classification of the securities If they are trading securities, the unrealized loss is included in earnings If they are available-for-sale securities, the unrealized loss is recorded as other comprehensive income and as a separate component of stockholders’ equity The rationale for this difference is that trading securities are actively managed and, therefore, any price changes should be included in earnings Unrealized gains and losses are not recognized on held-to-maturity securities 17-72 Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CA 17-5 Since Fontaine Company purchased 40% of Knoblett Company’s outstanding stock, Fontaine is considered to have significant influence over Knoblett Company Therefore, Fontaine will account for this investment using the equity method The investment is reported on the December 31 balance sheet as a long-term investment The account balance includes the initial purchase price plus 40% of Knoblett’s net income since the acquisition date of July 1, 2011 The investment account balance will be reduced by 40% of the cash dividends paid by Knoblett’s The cash dividends represent a return of Fontaine’s investment and, therefore, the investment account is reduced The income statement will report the 40% of Knoblett’s net income received by Fontaine as investment income Investment in Knoblett Co Cost of investment 40% of cash dividends 40% of Knoblett’s income received from Knoblett since 7/1/11 CA 17-6 Memo on accounting treatment to be accorded Investment in Spoor Corporation: Selig Company should follow the equity method of accounting for its investment in Spoor Corporation because Selig Company is presumed to be able to exercise significant influence over the operating and financial policies of Spoor Corporation due to the size of its investment (40%) In 2011, Selig Company should report its interest in Spoor Corporation’s outstanding capital stock as a long-term investment Following the equity method of accounting, Selig Company should record the cash purchase of 40 percent of Spoor Corporation at acquisition cost Forty percent of Spoor Corporation’s total net income from July 1, 2011, to December 31, 2011, should be added to the carrying amount of the investment in Selig Company’s balance sheet and shown as revenue in its income statement to recognize Selig Company’s share of the net income of Spoor Corporation after the date of acquisition This amount should reflect adjustments similar to those made in preparing consolidated statements, including adjustments to eliminate intercompany gains and losses The cash dividends paid by Spoor Corporation to Selig Company should reduce the carrying amount of the investment in Selig Company’s balance sheet and have no effect on Selig Company’s income statement CA 17-7 (a) Classifying the securities as they propose will indeed have the effect on net income that they say it will Classifying all the gains as trading securities will cause all the gains to flow through the income statement this year and classifying the losses as available-for-sale and held-to-maturity will defer the losses from this year’s income statement Classifying the gains and losses just the opposite will have the opposite effect (b) What each proposes is unethical since it is knowingly not in accordance with GAAP The financial statements are fraudulently, not fairly, stated The affected stakeholders are other members of the company’s officers and directors, company employees, the independent auditors (who may detect these misstatements), the stockholders, and prospective investors Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) 17-73 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CA 17-7 (Continued) (c) 17-74 The act of selling certain securities (those with gains or those with losses) is management’s choice and is not per se unethical Generally accepted accounting principles allow the sale of selected securities so long as the inventory method of assigning cost adopted by the company is consistently applied If the officers act in the best interest of the company and its stakeholders, and in accordance with GAAP, and not in their self-interest, their behavior is probably ethical Knowingly engaging in unsound and poor business and accounting practices that waste assets or that misstate financial statements is unethical behavior Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com FINANCIAL REPORTING PROBLEM (a) P&G reports $202 million in investments in 2007 Investment securities consist of readily-marketable debt and equity securities These securities are reported at fair value Unrealized gains or losses on securities classified as trading are charged to earnings Unrealized gains or losses on securities classified as available for sale are recorded in Other Comprehensive Income Investment securities are reported in current assets on the Balance Sheet (b) Investment securities and derivatives are reported at fair value The estimated fair values of financial instruments, including certain debt instruments, investment securities and derivatives, have been determined using market information and valuation methodologies, primarily discounted cash flow analysis Other financial instruments, including cash equivalents, other investments and short-term debt, are recorded at cost, which approximates fair value (c) According to Note 6, P&G (as a multinational company with diverse product offerings), is exposed to market risks, such as changes in interest rates, currency exchange rates and commodity pricing To manage the volatility related to these exposures, the Company evaluates exposures on a consolidated basis to take advantage of logical exposure netting For the remaining exposures, the Company enters into various derivative transactions Such derivative transactions, which are executed in accordance with the Company’s policies in areas such as counterparty exposure and hedging practices, are accounted for under SFAS No 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted The Company does not hold or issue derivative financial instruments for speculative trading purposes At inception, the Company formally designates and documents the financial instrument as a hedge of a specific underlying exposure The Company has established strict counterparty credit guidelines and normally enters into transactions with investment grade financial institutions Counterparty exposures are monitored daily and downgrades in credit rating are reviewed on a timely basis Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) 17-75 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com FINANCIAL REPORTING PROBLEM (Continued) The Company’s policy is to manage interest cost using a mixture of fixed-rate and variable-rate debt To manage this risk in a cost efficient manner, the Company enters into interest rate swaps in which the Company agrees to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated by reference to an agreed-upon notional principal amount Interest rate swaps that meet specific conditions under GAAP are accounted for as fair value hedges Changes in the fair value of both the hedging instruments and the underlying debt obligations are immediately recognized in earnings as equal and offsetting gains and losses in the interest expense component of the income statement The Company primarily utilizes forward exchange contracts and purchased options with maturities of less than 18 months and currency swaps with maturities up to years These instruments are intended to offset the effect of exchange rate fluctuations on forecasted sales, inventory purchases, intercompany royalties and intercompany loans denominated in foreign currencies and are therefore accounted for as cash flow hedges Certain instruments used by the Company for foreign exchange risk not meet the requirements for hedge accounting treatment In these cases, the change in value of the instruments is designed to offset the foreign currency impact of intercompany financing transactions, income from international operations and other balance sheet revaluations Raw materials used by the Company are subject to price volatility caused by weather, supply conditions, political and economic variables and other unpredictable factors To manage the volatility related to certain anticipated inventory purchases, the Company uses futures and options with maturities generally less than one year and swap contracts with maturities up to five years These market instruments are designated as cash flow hedges under GAAP 17-76 Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com COMPARATIVE ANALYSIS CASE THE COCA-COLA COMPANY and PEPSICO, INC (a) (1) (2) (3) Cash used in investing activities Cash used for acquisitions and investments Total investment in unconsolidated affiliates at 12-31-07 Coca-Cola $(6,719) PepsiCo $(3,744) $(5,653) $(1,320) $ 7,777 $ 4,354 (4) Coca-Cola’s cash used for acquisitions and investments represented 84% ($5,653 ÷ $6,719) of its cash used for investing activities while PepsiCo’s cash used for acquisitions of investments equaled 35.3% ($1,320 ÷ $3,744) of its cash used for investing activities Coca-Cola’s total investments were approximately 1.9 times as large as PepsiCo’s and represented 18% ($7,777 ÷ $43,269) of its total assets while PepsiCo’s investments equaled only 12.6% ($4,354 ÷ $34,628) of its total assets Based on the preceding data, it can be concluded that investments are substantially more important to Coca-Cola than to PepsiCo (b) (1) Coca-Cola reported the following equity investments on its December 31, 2007 balance sheet: Investments and Other Assets Equity method investments Coca-Cola Enterprises Inc Coca-Cola Hellenic Bottling Company S.A Coca-Cola FEMSA, S.A de C.V Coca-Cola Amatil Limited Other, principally bottling companies (in millions) $1,637 1,549 996 806 2,301 (2) Coca-Cola reported “cost method investments, principally bottling companies” in the amount of $488 million in its December 31, 2007 balance sheet Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) 17-77 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com COMPARATIVE ANALYSIS CASE (Continued) (c) At December 31, 2007, Coca-Cola reported in its Note 11 on Financial Instruments the following: December 31, 2007 (in millions) 17-78 Cost Gross Unrealized Gains Gross Unrealized Estimated Losses Fair Value Trading securities $102 $ $(3) $101 Available-for-sale securities $252 $247 $(2) $497 Held-to-maturity securities $ 67 — — $ 67 Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com FINANCIAL STATEMENT ANALYSIS CASE UNION PLANTERS (a) While banks are primarily in the business of lending money, they also need to balance their asset portfolio by investing in other assets For example, a bank may have excess cash that it has not yet loaned, which it wants to invest in very short-term liquid assets Or it may believe that it can earn a higher rate of interest by buying long-term bonds than it can currently earn by making new loans Or it may purchase investments for short-term speculation because it believes these investments will appreciate in value (b) Trading securities are shown on the balance sheet at their current fair value, and any unrealized gains and losses resulting from reporting them at their fair value are reported as part of income Available-forsale securities are reported on the balance sheet at their fair value, and any unrealized gains and losses resulting from reporting them at their fair values are reported as other comprehensive income and as a separate component of stockholders’ equity until realized Held-tomaturity securities are reported at their amortized cost; that is, they are not reported at fair value Note that Union Planters has no held-tomaturity securities (c) Securities are reported in three different categories because these three different categories reflect the likelihood that any unrealized gains and losses will eventually be realized by the company That is, trading securities are held for a short period; thus, if the bank has an unrealized gain on its trading security portfolio, it is likely that these securities will be sold soon and the gain will be realized On the other hand, available-for-sale securities are not going to be sold for a longer period of time; thus, unrealized gains on these securities may not be realized for several years If securities were all grouped into a single category, the investor would not be aware of these differences in the probability of realization (d) The answer to this involves selling your “winner” stocks in your availablefor-sale portfolio at year-end Union Planters could have increased reported net income by $108 million (clearly, a material amount when total reported income was $224 million) Management chose not to sell these securities because at the time it must have felt that either the securities had additional room for price appreciation, or it didn’t want to pay the additional taxes that would be associated with a sale at a gain, or it wanted to hold the securities because they were needed to provide the proper asset balance in its management of its total asset portfolio, or it would prefer to report the gain in the following year Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) 17-79 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com PROFESSIONAL RESEARCH: FASB CODIFICATION (a) According to FASB ASC 320-10-15-5, the guidance in the Investments—Debt and Equity Securities Topic establishes standards of financial accounting and reporting for both of following: Investments in equity securities that have readily determinable fair values All investments in debt securities Readily Determinable Fair Value (FASB ASC 320-10-Glossary) An equity security has a readily determinable fair value if it meets any of the following conditions: The fair value of an equity security is readily determinable if sales prices or bid-and-asked quotations are currently available on a securities exchange registered with the U.S Securities and Exchange Commission (SEC) or in the over-the-counter market, provided that those prices or quotations for the over-the-counter market are publicly reported by the National Association of Securities Dealers Automated Quotations systems or by Pink Sheets LLC Restricted stock meets that definition if the restriction terminates within one year The fair value of an equity security traded only in a foreign market is readily determinable if that foreign market is of a breadth and scope comparable to one of the U.S markets referred to above The fair value of an investment in a mutual fund is readily determinable if the fair value per share (unit) is determined and published and is the basis for current transactions (b) (c) See FASB ASC 320-10-35 35-18 For individual securities classified as either available for sale or held to maturity, an entity shall determine whether a decline in fair value below the amortized cost basis is other than temporary 35-31 For example, if it is probable that the entity will be unable to collect all amounts due according to the contractual terms of a debt security not impaired at acquisition, an other-than-temporary impairment shall be considered to have occurred See FASB ASC 320-10-25 25-14 Sales of debt securities that meet either of the following conditions may be considered as maturities for purposes of the classification of securities and the disclosure requirements under this Subtopic: 17-80 The sale of a security occurs near enough to its maturity date (or call date if exercise of the call is probable) that interest rate risk is substantially eliminated as a pricing factor That is, the date of sale is so near the maturity or call date (for example, within three months) that changes in market interest rates would not have a significant effect on the security’s fair value Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com PROFESSIONAL RESEARCH (Continued) (d) The sale of a security occurs after the entity has already collected a substantial portion (at least 85 percent) of the principal outstanding at acquisition due either to prepayments on the debt security or to scheduled payments on a debt security payable in equal installments (both principal and interest) over its term For variablerate securities, the scheduled payments need not be equal See FASB ASC 320-10-50 50-10 For any sales of or transfers from securities classified as held-to-maturity, an entity shall disclose all of the following in the notes to the financial statements for each period for which the results of operations are presented: The net carrying amount of the sold or transferred security The net gain or loss in accumulated other comprehensive income for any derivative that hedged the forecasted acquisition of the held-to-maturity security The related realized or unrealized gain or loss The circumstances leading to the decision to sell or transfer the security (Such sales or transfers should be rare, except for sales and transfers due to the changes in circumstances identified in paragraph 320-10-25-6(a) through (f).) Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) 17-81 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com PROFESSIONAL SIMULATION Journal Entries (a) Available-for-Sale Securities Interest Revenue ($50,000 X 12 X 4/12) Investments 187,400* 2,000 189,400 *($37,400 + $100,000 + $50,000) (b) December 31, 2010 Interest Receivable Interest Revenue **Accrued interest: $50,000 X 12 X 10/12 = Accrued interest: $100,000 X 11 X 3/12 = 7,750 7,750** $5,000 2,750 $7,750 Measurement 17-82 Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com PROFESSIONAL SIMULATION (Continued) Explanation If Powerputt owns 30%, it will use the equity method to account for the investment As a result, this investment would not be reported at fair value and there would be no unrealized holding gains or losses Under the equity method, the investment carrying amount is periodically increased (decreased) by the investor’s proportionate share of the earnings (losses) of the investor and decreased by all dividends received by the investor from the investee Copyright © 2010 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) 17-83 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ... Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com SOLUTIONS... Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) 17-11 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com SOLUTIONS... Sons, Inc Kieso, Intermediate Accounting, 13/e, Solutions Manual (For Instructor Use Only) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com SOLUTIONS